During one-month period to 31st August 2019, major equity markets registered quite sharp falls. The FTSE ALL-World Index dropped by 3.62% over the period, though still up by 12.2% since the beginning of the year. The VIX index rose sharply by 34.8% to end the period at 18.45. Fixed interest products mostly rose in price terms leaving significant amounts of global government debt (approx. $17 trillion) on negative yields. Sterling was slightly weaker but the main monthly FX movers were in the Asian area. Precious metals rose in price terms while iron ore suffered a sharp decline.
The European Central Bank continues to err on the cautious side regarding economic projections, Mario Draghi giving strong hints of further help at the end July ECB meeting. At the time of writing Germany appears to be on the brink of a recession and calls for fiscal loosening are increasing. Political events have featured ECB appointments along with further signs of discontent in Germany and France, renewed Spanish election speculation and further Italian coalition division. US market watchers continued to grapple with ongoing tariff discussions (China, Mexico -and prospectively Europe,Japan), Federal Budget concerns, Iranian sanctions, Venezuela, North Korean meeting stalemate and Trump’s personal issues (Mueller, etc). US economic data has indicated a solid consumer trend although relatively buoyant first quarter GDP growth figures did include a large element of inventory building. Corporate results/forward looking statements have taken on a more cautious tone, especially related to tariff developments (actual or rumoured). Official interest rates were reduced 25bp on July 31st to a range of 2.0%-2.25% much as expected, and the accompanying statement left the door open for further adjustment. In the Far East, China flexed its muscles in response to Trump’s trade and other demands. Recent data releases pointed to 6.2% quarterly GDP growth, in line with lower expectations and featuring a relatively strong consumer contribution. Japanese economic growth was downgraded slightly to 0.8%, mainly on a weaker trade performance. The recent Upper House election result confirmed the LDP current strong position while at the Bank of Japan meeting, the current easier fiscal stance was reconfirmed. The VAT change, yet not confirmed, and further QE measures in line with major trading partners are being hotly debated. Relations between Japan and South Korea deteriorated.
The UK continued to report somewhat mixed economic data with stable developments on the government borrowing side, poor corporate investment , inflation a little higher than expected, weak relative GDP figures and deteriorating property sentiment, both residential (esp London) and commercial (especially retail).Business and market attention, both domestic and international, is clearly focussed on ongoing BREXIT deliberations under new Prime Minster ,Boris Johnson. Both the Chancellor and Bank of England Governor have made frequent references to the unsettling effects of any unsatisfactory Brexit outcome, as have a growing number of business leaders and independent academic bodies. The actual situation remains very fluid, and many options are still possible at the time of writing, including a time extension, while there remains a non-zero probability of a “no-deal”. Economic and corporate figures will inevitably be distorted over coming months, and it would not be a complete surprise if Uk entered a technical recession by the end of the third quarter.
Aggregate world hard economic data continues to show 2019 expansion of around 3.0%, although forecasts of future growth continue to be reduced the leading independent international organizations. There appears to be a growing chorus of further action on the fiscal front e.g. infrastructure spending, as other instruments e.g interest rates may have limited potential from current levels. Fluctuating currencies continued to play an important part in asset allocation decisions, volatile sterling being a recent example, while some emerging market currencies have been exceptionally volatile e.g. Turkey. Movements in the $/Yuan are also taking on increasing significance
Global Equities fell 3.62% over August, the FTSE ALL World Index now showing a gain of 12.2% since the year end, albeit following the very weak last quarter of 2018. The UK broad and narrow market indices, both fell by 4% to5% over the period, lagging world equities in both local and sterling adjusted terms by about 5% and 10% respectively, since the beginning of 2019. Asia, excluding Japan, and Emerging Markets showed the largest monthly falls. The VIX index rose a hefty 34.8% to a level of 18.45, but still down 27.4% down 46.1% since the beginning of the year.
Sector moves over August 2019 reflected relative outperformance by traditional defensive stocks in the areas of pharmaceuticals, telecoms and utilities, while oil and gas, mining and life stocks featured some double-digit price declines. Over the eight -month period, pharmaceuticals are showing an absolute gain of 19.4% while the worst performing UK sector, banking, is nursing a loss of 7.8%
Gilt prices rose 3.05% over the month, the 10-year UK yield standing at 0.32% currently. Other ten-year yields closed the month at US, 1.5%, Japan, -0.32%, and Germany, -0.52%. UK corporate bonds rose by over 1.7% in price terms ending August on a yield of approximately 2.42%. Amongst the more speculative grades, there were small yield falls for US High Yield although emerging market bonds fell in price terms. Floating rate bonds remained unchanged while the favoured convertible bond play gave up some of July’s sharp gain. See my recommendations in preference shares, convertibles, corporate bonds, floating rate bonds etc. A list of my top thirty income ideas (many yielding around 6%) from over 10 different asset classes is available.
The Japanese Yen was one of the main features during August, rising against all major currencies largely for perceived safe haven reasons. The Chinese Renminbi fell by nearly 4% against the US Dollar, the biggest monthly slide in 25 years.
A generally weaker period for most commodities on global growth concerns, although gold and some other precious metals rose. Iron ore was a particularly weak feature dropping over 27% during the month.
Over the coming months, geo-political events and Central Bank actions/statements meeting, will continue to dominate news headlines and market sentiment, in my view. To some extent, the slower economic growth forecasts that are appearing, will inevitably lead to some scale-back in corporate profit projections, although there may be offsetting fiscal and monetary effects. With growing numbers of government bond yields in negative territory, calls for more fiscal action will intensify.
US watchers will continue to speculate on the timing and number of further interest rate moves during the 2019/2020 period while longer term Federal debt dynamics, election debate and trade” war” winners/losers (a moving target) will affect sentiment. Corporate earnings growth will be subject to even greater analysis after a buoyant 2018, amidst a growing list of obstacles. Additional discussions pertaining to North Korea, Russia, Ukraine, Iran, and Trump’s own position could precipitate volatility in equities, commodities and currencies. In Japan market sentiment may be calmer after recent political and economic events although international events e.g. exchange rates and tariff developments, will affect equity direction. Economic data,has,if anything, been better than expected, a rare event at the moment! There is increasing speculation that China may announce more stimulative measures and key $/Yuan exchange rate levels are being watched closely. European investment mood will be tested by generally weakening economic figures and an increasingly unstable political backdrop
Hard economic data (especially final GDP, corporate investment, exports) and various sentiment/residential property indicators are expected to show that UK economic growth continues to be lack-lustre and any economic upgrade over current quarters appear extremely unlikely. The UK Treasury and the MPC have both produced rather negative economic medium-term projections, whatever the Brexit outcome! It is highly likely that near term quarterly figures (economic and corporate) will be distorted (both ways), and general asset price moves will be confused, in my view, by a mixture of currency development, political machinations, international perception and interest rate expectations.
In terms of current recommendations,
Depending on benchmark, and risk attitude, first considerations should be appropriate cash/hedging stance and the degree of asset diversification (asset class, individual investment and currency).
An increased weighting in absolute return, alternative income and other vehicles may be warranted as equity returns will become increasingly lower and more volatile and holding greater than usual cash balances may also be appropriate, including some outside sterling. Both equity and fixed interest selection should be very focussed. Apart from global equity drivers e.g. slowing economic and corporate growth and limited monetary response levers, there are many localised events e.g. Brexit, US elections, tariff discussions, political uncertainty, that could upset many bourses, still relatively close to recent record levels.
- I have kept the UK at an overweight position on valuation grounds. Full details are available in the recent quarterly review. However, extra due diligence in stock/fund selection is strongly advised, due to ongoing macro-economic and political uncertainty. Sterling volatility should also be factored into the decision, making process.
- Within UK sectors, some of the higher yielding defensive plays e.g. Pharma, Telco’s and Utilities have attractions relative to certain cyclicals, though watch regulatory concerns, and many financials are showing confidence by dividend hikes and buy-backs etc. Oil and gas majors may be worth holding despite the outperformance to date. Remember that the larger cap names such as Royal Dutch and BP will be better placed than some of the purer exploration plays in the event of a softer oil price. Mining stocks remain a hold, in my view (see my recent note for favoured large cap pooled play). Corporate activity, already apparent in the engineering (GKN), property (Hammerson,Intu), pharmaceutical (Glaxo, Shire?), packaging (Smurfit), retail (Sainsbury/Asda), leisure (Whitbread,Greene King), media (Sky), mining (Randgold) is likely to increase in my view, although the Government has recently been expressing concern about overseas take-overs in certain strategic areas.
- Continental European equities are preferred to those of USA, for reasons of valuation, and Central bank policy, although political developments and slowing economic growth need to be monitored closely. I suggest moving the European exposure to “neutral “from overweight. European investors may be advised to focus more on domestic, rather than export related themes. Look at underlying exposure of your funds carefully and remember that certain European and Japanese companies provide US exposure, without paying US prices. I have recently written on Japan, and I would continue to overweight this market, despite the 2017 and 2018 outperformance relative to world equities. Smaller cap/ domestic focussed funds may outperform broader index averages e.g. JP Morgan Japanese Smaller Companies and Legg Mason.FX will play an increasing role in the Japanese equity decision.
- Alternative fixed interest vehicles, which continue to perform relatively well, in total return terms, have attractions e.g. preference shares, convertibles, for balanced, cautious accounts and energy/ emerging/speculative grade for higher risk e.g. EnQuest,Eros. These remain my favoured plays within the fixed interest space. See recent note
- UK bank preference shares still look particularly attractive and could be considered as alternatives to the ordinary shares in some cases. Bank balance sheets are in much better shape and yields of 6%-7% are currently available on related issues while a yield of 9.1% p.a., paid quarterly, is my favoured more speculative idea.
- Alternative income and private equity names exhibited their defensive characteristics during 2018 and are still favoured as part of a balanced portfolio. Reference could also be made to the renewable funds (see my recent solar and wind power recommendations). Both stocks registered positive capital returns over 2018 on top of income payments of approx. 5%. And are still strongly recommended as is the new issue. Selected infrastructure funds are also recommended for purchase but be aware of the political risk. New issues in this area e.g. Aquila and JPM are likely to move to premiums.
- Any new commitments to the commercial property sector should be more focussed on direct equities and investment trusts than unit trusts (see my recent note comparing open ended and closed ended funds), thus exploiting the discount and double discount features respectively as well as having liquidity and trading advantages. However, in general I would not overweight the sector, as along with residential property, I expect further price stagnation especially in London offices and retail developments e.g. (Hammerson, Intu). Subscribers may read more on this subject in my latest quarterly review. One possible exception to the sentiment above is the growing attractiveness of certain assets to overseas buyers. The outlook for some specialist sub sectors e.g. health (PHP equity and bond still strongly recommended), logistics, student, multi-let etc and property outside London/South-East, however, is currently more favourable. Investors should also consider some continental European property plays e.g SERE.
- I suggest a very selective approach to emerging equities and would continue to avoid bonds. Although the overall valuation for emerging market equities is relatively modest, there are large differences between individual countries. It is worth noting that a number of emerging economies in both Asia and Latin America have shown first quarter 2019 GDP weakness even before the onset of any possible tariff effects. A mixture of high growth/high valuation e.g. India, Vietnam and value e.g. Russia could yield rewards and there are signs of funds moving back to South Africa on political change. Turkish assets seem likely to remain highly volatile in the short term and much of South America is either in a crisis mode e.g. Venezuela, Argentina or embarking on new political era e.g. Mexico and Brazil. As highlighted in the quarterly, Chinese index weightings are expected to increase quite significantly over coming years, and there are currently large inflows into this area following the price weakness of 2018. One additional factor to consider when benchmarking emerging markets is the large percentage now attributable to technology. A longer-term index argument is also being made in favour of Gulf States, although governance issues remain a concern.
Full quarter report available to clients/subscribers and suggested portfolio strategy/individual recommendations will be available soon. Ideas for a ten stock FTSE portfolio, model pooled fund portfolios (cautious, balanced adventurous, income), 30 stock income lists, defensive list, hedging ideas, and a list of shorter-term low risk/ high risk ideas can also be purchased, as well as bespoke portfolio construction/restructuring.
Feel free to contact regarding any investment project.
Good luck with performance!
Ken Baksh Bsc,Fellow (UK Society of Investment Professionals)
2nd September 2019